Finance Bill 2016: Clause 26 – Relief for finance costs related to residential property businesses

By Technical Team on 11 Jul 2016

The amendments made by clause 26 to the provisions dealing with the restriction of relief for finance costs relating to residential property businesses (originally enacted in Finance (No 2) Act 2015) do not address the anomaly raised at the time by the CIOT, ie. its application to Interest In Possession Trusts1 (IIP trusts) and personal representatives (PRs) that carry on a property business in circumstances where there is low or nil net rental income after finance costs. The tax treatment undermines the basis of taxation of an IIP trust and, perhaps to a lesser extent, of PRs.

Suppose a property is let for £20,000 a year, net of allowable deductions, and the interest charge is also £20,000 a year. If the property is held in trust and the life tenant1 is a basic rate taxpayer, the trustees would have to pay tax at the basic rate on the gross rental income (20% x £20,000 = £4,000). In such cases there will not be sufficient net rental income to meet the tax liability payable by the trustees. Accordingly the trustees’ liability will have to be met out of other income or capital of the trust to the detriment of other beneficiaries. This is especially difficult where there is no other income and trust capital is illiquid.

A basic rate paying life tenant can then effectively reclaim the tax paid by the trustees, as there is no liability on the disallowed interest due to the availability of the tax reducer2 (tax due £4,000 less tax reducer of £4,000). Despite there not being any income in the trust to which he is entitled, he or she would benefit from the tax paid by the trustees to the detriment of the remainderman.

If PRs or IIP trustees have significant finance costs, it will be a problem. This will be particularly so for IIPs. For PRs, although they would have to find the tax from other capital, the legatee who is getting the diminished capital may well be the same person who was getting the income anyway, so it would come out ‘in the wash’. This would not be the case for an IIP, as the life tenant and remainderman would be different people and the former is ending up better off at the expense of the latter.

As PRs and IIPs are basic rate taxpayers, it would be better to exclude them from the provisions in the same way as non-resident companies are excluded by virtue of ITTOIA 2005 section 272A(5). In that way the trustees / PRs would pay basic rate tax on the net profit. The disallowance would then be made at beneficiary/legatee level (with a corresponding reducer) in the same way as if the rental business was carried on by the individual thereby reflecting the underlying principle of an IIP trust that the beneficiary is treated as though he/she owns the asset directly because they have the entitlement to the income.


[1] An interest in possession trust is a form of legal arrangement where at least one of the beneficiaries has a right to enjoy the income generated by the trust or to enjoy the trust assets (eg by living in a property belonging to the trust). This beneficiary is known as the ‘life tenant’. This might commonly be a trust where the surviving spouse has the income for life and the remainder passes to the children (making them the 'remaindermen') on the death of that spouse.  You might do this for example because you worry that your spouse is going to remarry and the assets would go to her new family – a valid use of trusts providing for the current generation while protecting the future generation.
[2] That is, the relief at basic rate on the disallowed costs. The provisions operate by disallowing finance costs and then giving relief only at the basic rate on the disallowed by way of a tax reduction hence tax reducer.

Technical Team

Posted in: Property Taxes